True market failure = so much federally-guaranteed funny money floods the market that prices get pushed up to unsustainable bubble valuation levels, leading many households who take the bait the way to financial ruin.
Charles Lane
Editorial Writer
When Uncle Sam plays banker
By Charles Lane, Published: April 9
Today’s lesson on How America Really Works begins with a question: What is the largest and most influential financial institution in the world? It’s not J.P. Morgan, or even Goldman Sachs. It’s the U.S. government.
That’s the verdict of Brookings Institution banking expert Douglas J. Elliott, and the numbers back him up. By the end of 2011, the federal government’s housing, farm, business and educational credit programs had $2.7 trillion in loans and guarantees outstanding. That’s not counting the $5 trillion-plus, mostly related to housing giants Fannie Mae and Freddie Mac, that Washington took on its books amid the financial crisis that began in 2008.
Tom Toles on the budget battle:?Collection of cartoons on the federal budget and economy.
We’ll find out soon enough whether these “emergency” programs gradually become permanent, as did Great Depression emergency programs such as the Export-Import Bank and the Federal Housing Administration (FHA).
The federal government’s massive intervention in the credit markets, necessary as it might be in a crisis, shows that our nation often honors its commitment to free markets in the breach.
It is also cause for concern — if, like me, you believe that one of the Great Recession’s lessons is that financial commitments can be a lot riskier than they appear. To make matters worse, current law obscures, rather than clarifies, the risks to taxpayers in the government’s portfolio.
Federal lending is always done in the name of some socially beneficial objective that the private banking system would insufficiently support, if left to its own devices.
Take, for example, student loans. A well-educated populace produces a more civilized, more productive society. Banks are not generally in the habit of making long-term, uncollateralized individual loans; ergo, it makes sense for the government to advance tuition money to would-be college students. Economists call this correcting “market failure.”
Nevertheless, when government decides how to allocate scarce resources, it sometimes strikes the wrong balance. Some categories of federal credit — rural utilities, railroad upkeep, small business — benefit interest groups with no clear payoff for the overall economy.
The social benefits of government-backed student loans may indeed outweigh their costs. But even this program distorts the markets it’s meant to repair. A guaranteed flow of tuition dollars weakens colleges’ incentive to restrain costs. Tuition rises and students must borrow more.
Over the past generation, federal credit support for housing boosted homeownership rates — but not sustainably. The national investment in home mortgages was a lot more vulnerable to the ups and downs of the business cycle than a series of Congresses and presidents of both parties had supposed. The resulting excess supply may burden the economy for years.
Some experts believe that the government’s $706 billion student loan portfoliosignifies a similar bubble in higher ed.
Federal credit programs are here to stay. Even if there were a consensus to unwind them all, doing so would be impractical in the short run. Meanwhile, in select cases, federal lending or loan guarantees may correct true market failures.
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